LONDON, May 2 (LPC) - Leveraged loan bankers are facing a reduction in earnings as sponsors continue to drive down fees, taking advantage of increased competition between lenders amid low deal flow.
Bankers have typically hit budget based on underwriting fees, being generously rewarded to take a view on assets and sell down risk.
However, fees have been squeezed in both the European and US leverage loan markets and in some cases as much as halved as deal flow compressed during the first quarter, with Europe experiencing a ten-year low, according to LPC data.
“People are mispricing risk to compete with each other. They are not being paid for the risk they are taking on at all. It is back to picking up pennies in front of the steam roller while at the same time telling the steam roller to go faster,” a capital markets head said.
While the US leveraged loan market has shifted around 25bp to 2% from a 2.25bp underwriting fee, an overbanked Europe has experienced far more dramatic changes to around 1.25%-1.50% from 1.75%.
Fees have been around the 1.5% mark in Europe for around six months, prior to which they were around 1.75% for about two years, with a brief respite at 1.75%-2.0% in December 2018 when the market was more cautious amid concerns over the US-China trade war and Brexit.
Yet a 25bp ‘pay away’ for banks in Europe to access flex language has eroded fees even further to 1.0%-1.25%, impacting banks’ ability to hit budget and their appetite for leveraged finance altogether.
“At Christmas time people were more nervous so some deals were being talked about at 2%. It is not totally generic. While trickier deals may still be 2%, other deals are getting done at 150bp or lower. If lower, lenders are being stupid,” said the head of capital markets.
While some banks are willing to take a haircut on fees, others are digging in their heels and refusing to be paid less than 1.75%, some bankers said.
“We’ve said no to sponsors if they offer lower than 1.75% on an underwrite,” a second capital markets head said.
The US has managed to maintain a greater level of market discipline compared to Europe and European bankers long for US-led cross-border deals, where US fees are adopted across the pond.
However some aspects of the European market, such as a ‘pay away’ to access pre-agreed flex terms are now being forced upon US deals. Some sponsors require banks to pay a 25bp fee to use flex terms, and in some cases are now demanding 50bp for the purpose.
Some sponsors are more aggressive than other. Partners and PAI Partners have been singled out as more aggressive, while KKR and CVC that have been known to be ruthless in some areas have been pretty fair when pricing risk, several sources said.
“Avoid the sponsors beginning with P, they’re the most aggressive,” a senior banker said.
Fees on lower paid, less risky ‘best efforts’ deals are also under pressure, reaching as low as 75bp, a second senior banker said.
At the same time, some sponsors are seeking to reduce their relationship banking lists in Europe, from around 30 to 20 in the face of reduced deal flow.
“Sponsors can’t be bothered to received calls from banks the whole time, asking what’s going on. They can’t possibly keep handing out favours,” a third senior banker said.
Blackstone, among other buyout firms, has held conversations with banks in recent weeks about whether they should form part of a preferred relationship list.
“It isn’t easy but if we’re cut from one sponsor’s list hopefully we’ll remain on another. It all evens out,” a syndicate head said.
“There are way too many arrangers in Europe. It has been a very recent conversation but one that has been heard many times over the last few weeks. Sponsors are basically reviewing their regular relationships and trying to streamline them as they don’t have enough business to go around. We all want to do the business but the reality is that the European market remains over banked so borrowers will always get their way,” the syndicate head said.
Commercial banks are expected to suffer the most if these lists are culled.
The changes come as private equity firms adjust the way they reward underwriting banks on European buyout loans to favour investment banks over commercial banks, and gain greater control over who is holding the debt.
Underwriting fees and loan commitments are usually equally distributed based on the amount of balance sheet that banks were willing to provide in Term Loan B and undrawn revolving credit facilities.
But private equity firms are now reducing the amount of RCFs that investment banks have to provide and giving them a bigger share of the more profitable TLB underwrite. Commercial banks, on the other hand, are being asked to hold more low-yielding RCF paper and underwrite less of the TLB business, which is squeezing their returns. (Editing by Christopher Mangham)